Today I want to talk about the difference between top down and bottom up calculations in business planning.

When I meet with clients, much of our time is spent around crafting a business plan that sets the business owner up for success – whether they’re going after outside funding or the plan will remain an internal strategy document – and one of the things that nearly every entrepreneur I’ve ever worked with misses is bottom up calculations.

Many of you are probably shaking your heads in confusion so let me explain. Top down calculations for a company figuring out potential annual revenues look something like this: “The total U.S. market for widgets is $20 billion so if we get just one half of one percent of the market we’ll be a $100 million revenue company.” They’re called top down because you’re starting at the top, the high level, the whole market, and working your way down to your overall business.

The trouble with this is that it has no strategy attached to it whatsoever. Cool, you can do math to figure out that one half of one percent of $20 billion is still a lot of money, but it doesn’t mean anything for your business. I could say if I just managed to get one half of one percent of Ben and Jerry’s sellers to give me a free pint of ice cream I would eat Ben and Jerry’s for a year at no cost, but I’m probably not going to be buying extra freezers to house all of my Ben and Jerry’s because I have no plan for making that happen. In a business plan, it’s the HOW that we need to focus on to produce the what, not the what itself. If you have no how, you just have a top down calculation and you’re giving yourself away as being naive about how challenging it is to acquire a customer and making yourself look unsophisticated.

So that brings us to bottom up calculation, which will give you a more accurate prediction of the future of your business, if you do them right. Now, in contrast to top down, which started at the high level and moved to down to the business, bottom up starts at the individual sale and moves up to the overall business. So, for example, if you’re going to use Adwords as one of your marketing paths, you might say, “Okay, I will run ads with abc keyword, which has an average cost per click of x, an average click through rate of y, and average conversion rate of z, for an average sale of $lmnop and build up from the cost to acquire one customer to the total projected revenue for the business. You can see that the bottom up calculation is inseparable from the plan for how you will achieve that final revenue number, so it’s a more useful method of estimating. If you notice that you have revenues in your pro forma income statement that are not directly accounted for with a marketing expense, you’re probably not using bottom up and likely want to take another look and see what you’re basing your revenue predictions on.

If you’re an aspiring entrepreneur, the best thing you can do for yourself is to just get started. Pick up my business planning ebook here to be guided through the whole business planning process for less than $5.More of a video person than a text person? Click here to try my ecourses instead.

Today I’m revisiting a topic I have covered before but needs to be covered again – the basics of writing a business plan. In the sea of information out there on the internet, stuff gets buried, so even though I have made this video before I am updating now and we’ll walk through the key components of a solid business plan.

Now, I know people out there like to constantly debate the merits of a business plan and whether entrepreneurs should bother creating one. I’ve commented on that silly debate before so I won’t do so here and will just assume you agree with me that you do need a business plan of some sort or you wouldn’t have clicked on this. Besides, if you want outside funding, you need to have one and, even if you’re not in search of outside funding, it’s always a good idea to have completed some solid market research and laid out your marketing, financial, and operational plans before you get too deep into running the day-to-day of your business.

With that said, here are the basics of what you should include the plan:

First up is your executive summary – and this is really only necessary if you’re creating a formal plan – if you want to pull together the components to get your strategy on track but you’re not submitting the plan to any outsiders in search of funding, you can skip this. Basically, it’s the cliff’s notes to the business plan and should be concise and compelling so that any potential investor who reads it is interested enough to continue on to the full plan, which will contain the real meat. I tend to write the executive summary last so I can pull the info I need about the company and its business model, management, competition, and marketing and financial plans from the rest of the plan.

The next section is the description of the business. Here you say what your business does, provide information about its products and services, and explain the business model. This forces you to fully think through how you’re going to bring in money so you and any potential investors understand where the revenues will come from.

Next you need to provide an in depth marketing plan. Here is where you explain in detail why what you have to offer is so special and how you’ll make sure your customers know that so they’re willing to shell out cash to buy it from you. You need to perform some market research and competitive analysis so you know who and where your customers and competitors are. This section is incredibly important because, if you can’t clearly explain how you’ll bring in customers, then you really don’t have a business. Also remember, anything you discuss in this section must be directly related to the forecasts in the financials section. If you say you’re going to bring in a million new customers in the first 6 months, you’d better have a marketing plan that justifies that type of growth and have included the marketing expenses in your financials. Lots of people underestimate the importance of creating a thorough marketing plan and then fall short when they actually open their doors. Remember, just saying you’re going to do email marketing to bring in clients isn’t enough. You need to say where you’re going to get your email list from, what the open, click through, and conversion rates are for that type of list to justify the number of customers you project, and then include the costs of buying and sending to that list in your financial plan.

After your marketing plan comes the operational plan. Here you explain how stuff is going to get done. Where will your employees come from? How much do they cost? What about supplies and equipment, R&D, compliance with regulations? This section is where you lay out how all of the gears will work together to ensure that stuff gets done when it needs to get done so that your company continues to move forward.

Next you should identify your corporate structure – what type of business entity you chose and why. If you’re not sure what the best entity for your business is, I have an old video you can check out and will be creating an updated version soon.

After that you’re onto the management team. Here you explain who is in charge of what and why. This is another piece of the puzzle that many people ignore if they’re not seeking outside funding, but you shouldn’t. You need to seriously think about who will be included in your executive team and what they contribute. Having your best friend be your Chief Technology Officer when his background is accounting makes no sense. Be honest with yourself about who should take on the key roles in your company and make sure that they’re qualified. Don’t stack your executive suite with dead weight because you feel like you should have a bunch of “directors” or “chiefs” or because you want to appease family or friends.

Finally, you need to create a financial plan for your company and forecast what will be happening with your money. First you should create pro forma financial statements to get an idea of whether your company will actually be profitable. If you don’t know how, you can take a look at my old videos about financial statements and pro formas but I’ll also be uploading new versions at some point in the future. If you really have no clue what you’re doing, you should probably bring someone in to help you create the financial. Remember that you need to have an explanation for every number you put here, so go back to your marketing and operational plans to make sure you don’t miss any expenses and you’ve justified any revenues. Once you have these completed, if you’re looking for investment, you’ll need to discuss the financing you propose.

Now, these are just the basics of a business plan and some more formal plans may have additional information. However, if you thoroughly complete all of these sections, you’ll be in good shape to move forward with launching your business solo or recruiting investors to work with you.

If you’re an aspiring entrepreneur, the best thing you can do for yourself is to just get started. Pick up my business planning ebook here to be guided through the whole business planning process for less than $5.More of a video person than a text person? Click here to try my ecourses instead.

Clearly, the first step to becoming a real entrepreneur instead of an aspiring entrepreneur is to come up with a great business idea, but that phrase can be a little deceptive. There is a difference between a great idea and a great idea for a business. There are many, many ideas that are beyond cool, that wouldn’t actually make great businesses. For example, providing free meals to every hungry child is a noble idea, but it’s clearly not a great business as you wouldn’t want to charge your customers and wouldn’t be able to make any money. How about a tool for consultants that drastically reduces the number of hours it takes them to service each client by automating huge portions of the work they used to do? That’s an awesome idea, right? But maybe it won’t be the billion dollar business you dreamed of because most consultants charge by the hour and it’s tough to get someone to pay you money for something that means they now have to charge less for their work, reduces their average customer value, and therefore lowers their margins.

Finding a great business idea is not just about coming up with something that is really cool; it’s about coming up with something that is really cool and that lots of people are willing to pay money for. The conventional wisdom out there is that you should find your next business idea by identifying a problem and then developing a solution for that problem. That’s absolutely correct, but there’s a little more to it than that. You need to identify and develop a solution for a problem, but you also need to be able to get people to pay good money for that solution – more money than that solution costs you to produce and deliver. That means that you need to understand your target customer before you know if you have a good business idea. Don’t know who your target customer is or if there are enough target customers out there? You’d better figure it out fast. To start, try taking a look at a couple of my older videos about creating target customer personas and doing market research.

The bottom line is that while most new entrepreneurs are asking themselves if their idea is cool and new to decide whether or not to pursue a business, they should be asking if it’s something that enough customers will pay for. A super boring but easily salable idea is a way better business than a super cool idea that nobody will pay for, period.

To get you started be honest with yourself about the following questions:

What is the problem I’m solving and who am I solving it for?

What are people currently using to address this problem and why would they would go through the effort of switching to my solution?

Is the customer going to pay me more for this solution than it costs me to market, produce, and deliver that solution?

Have I verified my assumptions about the customer by talking to them or am I building my solution in a bubble based on my own experience only?

If you’re honest with yourself about these questions, you’ll be well on your way to determining if you actually have a great business idea, or if you just have a really cool idea that maybe you can pursue as a hobby.

Creating pro forma financial statements is tough for anyone, especially new entrepreneurs, and there are a few common mistakes that I see those entrepreneurs make time and time again. Since the same missteps seem to trip up tons of newbies, I figured I’d share some of the ones I see most often to help prevent you from falling into the same trap. So, here are some of the top financial projection bloopers entrepreneurs make so that you can avoid them as you build your own pro formas.

While some may tell you otherwise, a business plan – whether formal or informal – is vitally important to any entrepreneur as he or she begins to move forward with starting and growing his or her business. This video gives a brief overview explaining the basic components that every entrepreneur should include in the business plan for his/her small business or startup.